NY futures ended the reporting period slightly lower, as December gave up another 31 points to close at 81.49 cents.

The market made a feeble attempt to rally this week, as back-to-back winning sessions propelled December briefly above the 84 cents resistance level on Tuesday, but the lackluster volume and the declining open interest were clear indications that the advance had no legs.

In order to validate a move we need to see rising volume and increasing open interest, but what we are currently witnessing is simply a slow reduction of both spec longs and trade shorts. Daily average trading volume was at just over 18k and December open interest dropped by nearly 7k to a 147k contracts, while total open interest slipped around 5k to 253k contracts, which is near the lowest reading of the year.

This market action is reflected by the latest CFTC reports. The spec/hedge report showed that during the week leading up to August 14, specs had reduced their net long in futures and options by 1.68 million bales to 7.87 million bales. Index funds were basically unchanged at 8.03 million bales net long.

The trade covered 1.67 million bales during the same period, thereby reducing its net short to 15.90 million bales. Today’s ‘on-call’ report showed that mills have been quite active fixing cotton last week, as outstanding on-call sales dropped by 1.03 million bales to 14.87 million bales as of last Friday. Most of these fixations were in December, which saw its unfixed balance drop by 0.93 to 4.11 million bales. Fixations continued this week and they have been providing support for the market at around 81-82 cents.

This trimming of positions has taken its toll on volatility, which has dropped from around 22% to 19% since last Thursday. This tells us that traders are giving up on the idea of a runaway market, but they also don’t seem to be afraid of a collapse thanks to the still large amount of unfixed sales.

US export sales were nothing to brag about at 199,900 running bales for both marketing years, with Vietnam’s 73,000 bales accounting for the lion’s share. There were still 18 markets buying, while 22 destinations received shipments of 165,000 running bales. For the current season we now have commitments at 9.0 million statistical bales, of which around 0.5 million bales have so far been exported. Sales for the 2019/20-season are at just under 1.4 million statistical bales.

Although emerging market currencies seem to have stabilized for now, we are getting quite uneasy about the current geopolitical and economic environment. Are currency depreciations in important economies like Argentina, Turkey, Russia, China, Chile or South Africa the proverbial ‘canary in the coal mine’, similar to what the sub-prime crisis was in 2007? When we look beyond the S&P 500 stock index, which is still trading in record territory, we see plenty of warning signs out there.

For example, all major European stock indexes are now in the red for 2018, while the European Bank Index is in a bear market (=down 20% or more from its 52-week high), and so are the MSCI Emerging Market Index and the CRB Industrial Metals Index. Copper, which is often referred to as ‘the metal with a PhD in Economics”, has dropped 21% since early June and cotton is not far behind it.

Then there are all the geopolitical tensions, like the trade war or the political struggle in the US, where the upcoming midterm elections have the potential to cause havoc in financial markets. It is therefore no wonder that many speculators and investors are playing it safe by reducing their exposures.

So where do we go from here? Markets don’t like uncertainty and at the moment there is plenty of it, which is why we believe that speculators will continue to reduce their net long holdings, while mills will continue to fix on a scale down basis.

We estimate that speculators are down to a 7.0 million bales net long by now, while mills have probably reduced their on-call position to around 14.0 million bales. In other words, there are about 2 bales to fix for every bale that speculators are net long, which should provide decent support. In addition there is a higher Indian MSP (Minimum Support Price) this season, which should add to underlying support.

As long as this liquidation process continues in an orderly fashion and no one panics, the market will likely move sideways within a fairly narrow range, as specs are selling into rallies and the trade is buying on dips.

From a technical point of view we need to keep an eye on the 200-day moving average, which is currently around 200 points below the market at 79.42 cents. A break below this level would likely open the door for more aggressive spec long liquidation.

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